Yellen Shouldn’t Apologize for Helping Wall Street

Oct. 14 (Bloomberg) -- Janet Yellen, President Barack
Obama’s nominee for chairman of the Federal Reserve, may or may
not face a Republican filibuster. She can expect, for sure, to
hear some tough criticisms of the Fed’s policies at her
confirmation hearings.

Most of the critics think money has been too loose as a
result of unorthodox monetary policies such as quantitative
easing. They’ve been warning for years that inflation would
accelerate in due course. So far no such trend has shown up in
the data: Although some goods have become more expensive, prices
in general haven’t risen much.

Another criticism that Yellen may face seems to have more
evidence going for it: that the Fed’s loose policies have
boosted the stock market rather than the economy. The Dow Jones
Industrial Average is above its peak from before the financial
crisis. The labor market ... isn’t. So, advocates of tighter
money say, the Fed has been increasing the country’s inequality
of income and wealth.

If Yellen is challenged on this point, she shouldn’t
dismiss it out of hand -- but she should explain why the concern
is exaggerated.

The most important argument she should make is that the
steps the Fed has taken to loosen money have, in fact, helped
the economy. The point can never be proved to everyone’s
satisfaction because there’s no way to know how the economy
would have done in an alternative universe where the Fed had run
a tighter policy.

We do have the example of the European Central Bank, which
has been tighter than the Fed. In 2011, for example, the ECB
raised interest rates twice. The euro area got a double-dip
recession, which the U.S. avoided. Europe’s unemployment rose
even as it fell here. The American economy is disappointing, but
the alternative of tighter money would probably have been
dreadful.

Past Recoveries

Yellen could also note that during the three recoveries
before this one -- recoveries in which the Fed wasn’t taking any
unorthodox steps to loosen money -- stocks improved before the
labor market did. The Dow did very well in 1982, 1991 and 2003.
In 1982 and 1991, the unemployment rate was still rising, and in
2003 it rose for half the year before settling back to roughly
where it was.

It’s also worth remembering that higher inflation doesn’t
always help stocks. David Glasner, an economist at the Federal
Trade Commission, has shown that while stocks have moved in
tandem with inflation expectations in recent years -- rising and
falling together -- they didn’t do so before the crisis.

One way of interpreting this finding is that during normal
times, the stock market doesn’t root for the Fed to loosen its
policy because that wouldn’t help the economy and thus increase
expected corporate profits. In a depressed economy, though, the
market starts rooting for looser money because it alleviates the
depression.

If that’s right, then the conflict between Wall Street and
Main Street that the Fed’s critics posit doesn’t really exist:
Looser money lifts real asset values -- including the real value
of stocks -- when it increases expectations of future economic
growth. It helps Wall Street, that is, by helping Main Street,
but some of the effects show up in stocks first.

Fed officials may have inadvertently obscured this point by
emphasizing that quantitative easing, the Fed’s bond-buying
program, helps the economy partly because people with more
valuable assets (including stocks and houses) spend more money.
That may be true, but the expectation of higher incomes in the
future is an earlier step in the causal chain.

Higher Inequality

It’s still possible that the Fed has been increasing
inequality. Higher inequality could, for example, result from
the higher growth that the Fed seems to have produced, because
some measures of inequality fell during the crash. But objecting
to the Fed’s policies on that ground would be perverse. Even
people who consider inequality a major problem that the
government should address generally don’t worry about such
cyclical swings. They worry about long-term trends -- which have
little to do with the Fed.

Is there any good reason for an egalitarian to oppose
current Fed policy? George Selgin, a professor of economics at
the University of Georgia, raises one. Some Wall Street firms,
he notes, have made a killing because of the particular trades
the Fed has made to carry out quantitative easing. He would have
preferred that the Fed not buy mortgage-backed securities.

But that isn’t what most of the Fed’s critics have in mind,
and it isn’t an argument in principle against monetary easing.
So though some senators may decide to use Yellen’s confirmation
hearings to portray the Fed as the servant of Wall Street, she
shouldn’t be defensive.

(Ramesh Ponnuru is a Bloomberg View columnist, a visiting
fellow at the American Enterprise Institute and a senior editor
at National Review.)